The aim of this study is to examine the impact of macroeconomic dynamics on credit risk of commercial banks in Bangladesh and also to assess the extent of default rate in the banking system as a result of extreme macroeconomic shocks. 

In order to identify the comprehensiveness of structural shocks, applying a VAR model in this study we impose sign-restricted 99th percentile value to disseminate shocks from each variable. The study finds that an extreme adverse inflation situation, contractionary monetary policy, and unexpected increase in exchange rate can boost the default rate by over 1%, 0.57% and 0.92% respectively. In addition, if all the extreme historical events occur for all macroeconomic variables, the default rate would increase by 2.52% after a lag. It indicates, adverse economic situation can threaten the banking sectors.

From the operational and regulatory perspective of banks, our findings are instructive. The results might help the policy makers to focus on the key macro variables for smooth operation and stability of the banking system.

Keywords:
Credit risk, Macroeconomic shock propagation